Trading stocks post earning announcements via PEAD anomaly can offer one of the most consistent and profitable ways to make money on Wall Street. The beauty of this trading approach is that you can bet and profit on both sides: bullish and bearish, which creates a very effective diversification under all market conditions. Nevertheless, not every stock that reports great / abysmal earnings will go through a significant PEAD phase.
Post-earnings announcement drift, or PEAD, is the tendency for a stock’s price to drift for several weeks (even several months) in the direction of the positive or the negative earnings announcement. It is an academically well-documented anomaly first discovered by Ball and Brown in 1968. Since then, it has been studied and confirmed by countless academics in many international markets.
This phenomenon can be explained with several hypotheses. The most widely accepted explanation for this effect is investors’ under-reaction to earnings announcements. It is also widely believed that there is a strong connection between earnings momentum and price momentum.
Not every stock that reports great / abysmal earnings will go through a significant PEAD phase. Some of the stocks fail to attract new buyers / sellers in the days after the earnings announcements and hence, fail to produce desired returns. In other words, there is no easy way to predict which stock will experience PEAD and which will not.
How I Trade PEAD Stocks
There are certain things that help me identify stocks that start their drifts and could potentially deliver great returns. This is what I do on a daily basis:
- Positive and Negative Surprises Watchlists. I track potential PEAD stocks via 2 watchlists: Positive and Negative Surprises. I usually day trade big surprise moves which keeps me well informed of all of the major movers on Wall Street.
- Stock price follow through. I observe how stock price moves following the earnings announcement during the next several days.
- Tape (order flow). I track big trade transactions to see how large players are positioning themselves post announcement. I want to see big bullish or bearish bets on a continuous basis.
- Options tape. I track options Time and Sales for the stocks I follow. Again, as with the share tape, I want to see big bets made by the option traders in favor of the direction I expect the stock to move.
- News Post Announcement. I also read all of the relevant news on all of the stocks on my PEAD watchlists. For example, it helps when the Wall Street analysts revise their targets for the price.
- Daily progress sheet. Finally, I keep the daily progress of the share prices of all of the PEAD stocks on my watchlists. I rank them by price change since the day of the announcement.